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International Investing. It's not Foreign.

Tuesday, June 20, 2017
by Kevin Dehod

As Canadian-based investors, we have a tendency to be more comfortable investing in stocks that trade on the Toronto Stock Exchange (S&P/TSX Composite Index). We filter our investment universe around the companies we know and that we hear about in our local financial media.

Over the course of my 24 year career, I have found that, more often than not, when I discuss international investing with clients and other potential investors, there is initially a strong perception that international investing is foreign, and because of its unfamiliarity it must also entail more risk. (Note: we define international investing as investing in those companies that are domiciled outside of North America).

In our recently launched international video we address two misconceptions surrounding international investing. First, is it foreign? And second, is it riskier? International companies are embedded in our everyday lives, and as Canadians, we use their goods and services on a daily basis. See Figure 1 for a list of some of our international holdings and their products which Canadians use frequently.

Mainly known for its Samsung electronics (smart phones), but Samsung is a large corporation comprised of 80 companies, with activities in areas including construction, consumer electronics, financial services, shipbuilding and medical services.

Nissan (Japan)

Nissan is a familiar auto brand, and also operates its luxury brands under Infiniti.

Sony (Japan)

Though we often think of Sony electronics, Sony is a diversified business that includes consumer and professional electronics, gaming, entertainment, and financial services.

The second misconception is that investing internationally is riskier. Many investors have a home bias, and believe that investing in companies ‘close to home’ is safer. They feel more comfortable in these investments because they understand the environment in which these companies are headquartered in.

The truth is that incorporating international stocks into a Canadian-only equity portfolio can significantly enhance diversification and reduce overall portfolio risk. We wrote about this back in our June 2014 Market Intelligence article, “Stampede to the International Markets.”

There are over 30 major stock markets in the world, with about 97% of the world's stock market value being in companies that trade on non-Canadian stock exchanges. Canadian investors have a unique challenge with diversification given the concentrated sector exposure in our home market, the S&P/TSX Composite Index.

Materials, Energy, and Financials currently make up 67% of the S&P/TSX Composite Index (Materials and Energy at 33% and Financials at 34%). What this means is that when commodities are in an up-cycle, Canadian stocks tend to outperform. However, when commodities are in a down-cycle or a range bound cycle like we may currently be in, the S&P/TSX Composite Index returns can be lackluster and investors are missing out on a world of opportunities. I found it very interesting that during 2015’s weak performance, led by the commodity stocks, even the banking sector in Canada was hit. Investors diversifying into Canadian Financials away from Canadian Commodity stocks ended up with very little diversification.

Powerhouse sectors like technology, healthcare, consumer staples, and consumer discretionary are pretty much nonexistent within the Canadian stock market. These four sectors combined make up 13% of the entire Canadian stock market. The technology sector, for example, makes up just 2.90% of the S&P/TSX index. In contrast, technology has become much more prevalent in all our lives over the last 10 years. Being able to research this sector on a global basis, by looking at companies in China, Japan, South Korea, Latin America and Europe, opens up a whole new opportunity set for Canadian investors. Currently, we hold 13% of our international pool in the technology sector. This sector has been important in two ways. First, to provide diversification for our Canadian clients, thereby reducing risk, and second, it has provided numerous investment opportunities that have contributed to our international pool outperforming.

In Figure 2, we show the current sector weightings of our International Equity Pool compared to the sector exposure of the S&P/TSX Composite Index.

Figure 2: S&P/TSX Sectors vs. M&P International Equity Pool Sectors

Source: Bloomberg

There are, of course, risks associated with international investing. The two biggest risk factors, from our perspective, are currency risk and political risk.

On currency, we do not hedge our currency exposure within our international portfolio. Again, we view this currency exposure as a diversification benefit and not a risk. Within our investment process, we do not focus on forecasting macro factors, such as currencies. We instead build a diversified portfolio of international companies, in multiple sectors and currencies, with different economic drivers that contribute to their collective success. In the most recent example surrounding French elections, we invested in high-end exporters that would benefit from a lower Euro, as well as established domestic firms that would benefit from economic reforms and GDP growth.

With regard to political risk, we address this by avoiding certain countries all together if we view the political environment as too hostile, and more importantly that valuations do not reflect that risk. As global investors, we have accepted the fact that elections are going to be a source of uncertainty and that political regimes will come and go. While the outcomes can be unnerving in the short-term, it is simply part of the investing landscape. Our job is to assess how much the landscape has changed in the long-run, what it might mean to our international portfolio of companies, and make adjustments if required. In our experience, political shocks or events have often created great buying opportunities in high quality international companies.

International investing is not as foreign as many investors believe. In addition to providing important diversification and risk-reduction benefits for Canadian investors, it most importantly enhances portfolio performance. McLean & Partners’ International Equity Pool has not only provided higher returns than the Canadian stock market over the short and long-term, but also has outperformed our international equity benchmark index (Figure 3).

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